Need for Working Capital Management with Special Reference to

Rubber Industry

DISSERTATION SUBMITTED

IN PARTIAL FULFILMENT OF THE REQUIREMENT

FOR THE DEGREE OF

MASTER OF BUSINESS ADMINISTRATION

By

ZUBAIR ALAM

Under the Supervision of

DR N. HASAN

DEPARTMENT OF BUSINESS ADMINISTRATION

ALIGARH MUSLIM UNIVERSITY

ALIGARH 1981

• " < • --̂ "?-,

.<^ «

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V^ ^

I : s i v d - j

Det icated

to

My Mother

ACKNOWLEDGEMENTS

It is my utmost duty to pay the warmth of thanks

to all the obligatories, The persons with those this

work interacted from its first word to the last alphabete

are the sole creator and inspirator for my efforts to bring

out such a huge pub_lished work. Among these who become

everlasting in the memories are Dr. Najmul Hasan, my

supertisor whose invaluable guidence always give me the

last hope of survival. My close friends M / S Arif Husain,

Mohd. Saleem, Prakash, Arshad and Ishtiaq Ahmad Khan have

a lot contribution in the compeletion of this work.

For the inspiration by my brother Dr. Anwar Habib,

I owe my sincere indebtedness.

( ZU^AIR ALAM )

C O N T E N T S

PAGE NO.

INTRODUCTION ... i to ii

Definition ... 1

Cash Management ... 6

Management of Marketable

Securit ies ... 15

Management of Receivable

Credit Policy ... 17

Financing of Working Capital ... 25

Study of A.B.C. Rubber Co.

Ltd. ... 33

• * « * » • • * # • • * *

INTRODUCTION

This dissertation has been written by me as a

requirement for Master of Business Administration. The

present dissertation 'Need for Working Capital Management

with Special Reference to Rubber Industry' has been written

keeping in view the growing importance of working capital

in The Rubber Industry. At present every industry is facing

the problem of arranging working capital. The emphasis is

given on the requirements of working capital in the area of

particularly in Cash Management, Management of Receivable

and Management of Inventories. Due to light money market

it is not very easy to get working capital. In this work

I have established mainly on inventory management as the

major funds are blocked in the inventories and raw material.

By using more flexible inventory management we can meet out

the funds requirements by our own resources. Moreover,

return on investment can be increased by reducing the

volume of working capital at the same level of output. In

Rubber Industry raw materials are very costly and needs

huge investment. With the increased importance of working

capital management in mind the work is approched with the

awareness that at least it should contribute same thing

to Rubber Industries.

- n -

Methodology? The methodology adopted for this is by collection

of facts from ABC Rubber Co., Ltd. Watching their problems

in area of inventories and Receivables I have incorporated

my suggestions which will help the industry to maintian

their working capital requirements and all the time they will

not have to run to the banks and financial institutions for

the funds the reference have also been taken from various,

journals books and periodicals to explain the theoritibal

part of the project.

WORKING CAPITAL MANAGEMENT

INTRODUCTION:

Scarcity of resources set limits to wbat management can

do. And best utilization of resources is possible only by

availing the opportunities. Again more important is goal

oriented utilization of resources. The action of all depart­

mental managers, including finance should cause that they are

helping in achieving the objective of the firm that is maximi­

sation of value of the firm. Finance is the back-bone of

industry and very scared resource. And management of finance

has more importance than any other. Any industry whether it

is small or big needs capital of two types i.e. (l) Long term

of fixed capital and (2) short term or working capital.

(1) Long Term or Fixed Capital:- This capital is required

for long period investment. As it is required for the acqui­

sition of fixed assets such as land, building, plant and

machinery required by new industries to make a start and by

the established concerns for the purpose of expansion, replace­

ment modernisation and betterment or improvement.

(2) Short Term or Working Capital:- This is required to

finance floating assets like inventory (stock of raw materials

- 2 -

inclnding stores and other items used in the process of

manufacturing, stock-in-process and finished goods), receivable,

loans and advances and to provide funds for day-to-day needs.

What is working capital:

Working capital in simple terms is the amout of funds

which a company must have to invest for its day-to-day operations.

It can also be considered as that portion of the company's total

capital which is employed in short-term operations. Now the

question arises whether this amount should all the times be

available in the form of cash or not. Practically, it is not

necessary to keep the funds in cash form at all times. It can

take the form of near cash assets or even assets a little

farther from cash but yet in the process of moving towards the

cash form in a short period. Such items are stocks of raw

material and supplies needed for manufacturing, work-in-process,

finished goods awaiting sale, sundry good debtors, short term

investment, and money at short notice or money at call.

Concept of Working Capital:

There are two opinions about working capital concept -

one is the 'gross* concept and the other is 'net* concept. The

financial concept is 'gross concept'. The gross working capital

also known as circulating capital, is represented by the sum

total of all current assets (convertable in cash with in a

period of near one year) of the enterprises. The second is

- 3 -

the 'accounting* concept which is 'net concept'. The net

working capital is the difference between current assets and

current-libility. These two concepts are not to be regarded

as mutually exclusive. Each has its relevance in specific

situation.

Current assets comprises items which can be converted

into cash in the short run, say within a year, or within the

normal operating cycle of the business. Current liabilities

are expected to fall due or mature for payment in a short

period generally within a year and represent short-term

sources of funds. In above opinion there is no consideration

of time although the volume of working capital differers frora

time to time. In busy season more working capital is need as

fixed capital remains same. It the working capital has been

classified with a view of time as "Permanent Working Capital

and "Variable or Temporary Working Capital". Permanent

Working Capital is that amount which represent the current

asset required for lowest production on a continuing basis

over the entire year.

Variable or Temporary Working Capital is that amount

which represent the current additional assets. Seasonal or

Cyclical business need more variable working capital.

Definition of working capital given by the Accounting

Principles Board of the American Institute of Certified Public

Accountants, U.S.A.

- 4 -

"Working capital, sometimes called net working capital, is represented by the excess of current assets over current liabilities and identifies the relatively liquid portion of total enterprise capital which constitutes a margin or buffer for maturing obligations within the ordinary operating cycle of the business*'.

In summary, the gross and the net working capital

concepts present to distinct and important facts of working

capital management. There is no standard fixed what amount

of gross or net working capital an enterprise needs. Nor is

there any commitment to specific mix or piece-meal financing

tied to particular class of assets. There is no stipulation

that short-term uses should be wholly financed by short-term

sources. It is also not feasible in practice.

Every company has its own constraints and plans giving

rise to individual working capital problems and the available

data have to be identified and analysed to aid proper decisions.

The most important aim is to maintain a proper balance between

the magnitude of working capital and the general scale of

operations of the company which calls for constant vigilance

and coordination of an extensive range of decisions.

Working Capital Management:-

Worklng capital or circulating capital or current assets

of any firm forms a sizable part of its total investment.

Management of the funds committed to working capital, therefore,

assumes as much importance if not more as any other fixed

- 5 -

inTestment in the firm. Practically, it has been obserTed

that it is easy to arrange funds for putting up a new

industry but it is very hard to arrange and control working

capital for the constant running of the industry. Successful

running of industry mainly depend upon arrangement and control

of working capital through out the life of the firm. Many

of the firms have failed only with a reason that there was no

proper control on the working capital. To arrange finance is

not easy particularly in a country like India where ther is

controlled economy. The management of the working capital

is one of the major fields in financial management. The

aspects of management of working capital are :

1. Determining the Requirements of Working Capital:- It is

difficult to set quantative amounts of working capital for

individual firm. We have to consider various factor when

determin the requirement of working capital e.g. Nature of

business, Manufacturing Policies, Production Process, Growth

and expension of business. Turn-over, Business fluctuation

and variations, Devident policies, style of purchase and sales.

Financial growth and Export and Import policies of government.

2. Financing the Requirements:- Funds to finance theyRorking

capital can be obtained through long term sources or short

term credit. The three important factors are to be considered

when we consider to use long term or short term funds for

financing current assets: Flexibility, cost and risk*

- 6 -

3. Efficient Funds Utilisation Relating to Working Capital;-

Last and most important task involve in efficient

working capital management is the use of working capital.

Un necessary investment or untimely expenses results into

more of working capital which ultimately reduce the value of

profit.

CASH MANAGEMENT;

One of the main taks of financial management is to hold

and maintain an adequate, but no excessive cash position. Cash

is an obvious and inescapable input into company's operations

and as such it has to be available in sufficient doses according

to needs on a continuing basis. Cash is also the major and

much awaited output or result of the company's operations and

there is the need for effective plan to deploy this liquid

resource to utmost productive use.

A company that is growing fast and even turning out

handsome profits may be continuously faced with a state of

shortage of cash and a thread to the uninterrupted flow of

production. So, finidng adequate funds for operating needs

is a perennial preoccupation for the company's finance manager.

Paucity of cash, even on a teraprary phase, is a source of

trouble to most enterprises. Nor is it wise to have, on the

average, a lot of cash, which is not an earning asset. Hence

the importance of good cash management.

- 7 -

Why hold cash ?

According to the eminent British economist, Lord Keynes,

the desire to hold cash can be attributed to one or more of

the three motives:

1. The transactions motire

2. The precautionary motive

3. The speculative motive

I. The Transaction Motive;- The transaction motive arises

from the need for ready funds to make payment failing due in

the ordinary course of day-to-day business, such as payment

for purchases, payment of wages, payment of operating expenses

and payment of taxes and dividends. The operating needs have

to be promptly met and any delay will haunper production and

profitability. Imagine the lot of the finance manager who has

not planned for the necessary funds to pay the annual bonus

and suddenly finds himslef compelled to raise substantial funds.

Payments of taxes and dividends may raise serious problems, in

the absence of proper resources planning. Many are the votaries

of management by crisis, who repeatedly plead with creditors

to bear with them patiently until they manage to find the

resources to meet the liabilities. The aim of effective iiash •

management is to ensure smooth functioning }f day-to-day

business, by judicious direction of the flt>w of cash into and

out of the business, so that the operating and contractual

payments are promptly made.

- 8 -

The Precautionary Motivet- The precautionary motlTe comes from

a desire to keep a cash cushion or buffer to meet unexpected

contingencies. The degree of precaution will normaly bear an

universe relationship to the degree of predictability of cash

flows of the business. As a matter of abundant caution, many

companies had learnt the art of 'cultivating the rich uncle',

by establishing and maintaining good lasting link with

progressive banking institutions. Ready borrowing power is

the best antidote to emergency cash drains and facilitates

release of available cash resources for remunerative applications.

Where considered advisable, part of the precautionary balance

can also be held in the form of near money assets, especially

marketable securities.

The speculative motive covers instances where the intention is

to hold cash to be able to take advantage of shifts in security

prices, arising from changes in interest rates and other factors.

This is not a common feature of corporate financial management,

except in regard to finance and investment companies.

How Much to Hold?

What are the factors that influence the quantum of

transaction and precautionary balances to be held? The

following can be mentioned:

1. The expected net cash flows based on the cash

forecasts, taking note of the long-range and short-term

- 9 -

cash needs of the company.

2. Expectations as to the degree of possible deviations

from forecasts. To anticipate changes in cash flows

under varying circumstances, the probability concept

can be applied*

3. The maturity scheduled or the structure of the

different liabilities of the company.

4. The facility of readily drawable borrowing power in

times of emergency.

5. Management's views and attitudes in the matter of

liquidity risks, varying between caution and adv^l^ure.

CASH PLANNING:

The pursuit of everyday transactions of a company generates

cash inflows and outflows. Granting that operations are carried

out efficiently and successfully, presenting a long-run pattern

of accumulation of cash from current operations. The short-run

course, however, will not be smooth and steady and will be

symbolised by a variety of pressures and fluctuations which may

be attributed to seasonal factors, unexpected market turns,

production problems or financing difficulties. Within the

operating year, cash surpluses or cash deficits may appear

and reappear, at varying points of time, posing borrowing and

investing problems, "one may well imagine the adjustment

difficulties created by way of life involving fequent changes

- 10 -

between playing the millionaire and playing the pauper, so

it is with a corporation that finds itself varying between

cash surpluses and deficiencies". If the swings are steep

abrupt, financial problems get aggravated. Financial

planning can be directed to see that the fluctuations are

smooth and gadual, by effictive coordination of the inflows

and outflows of cash.

If the finance manager finds himself in the unenviable

position of ahving to overcome a sizeable cash shortage, his

action has to be instant and, oftentimes, expensive. He has

no time to consider several alternative before deciding on

an appropriate course of action. On the other hand, he has

to rush out and borrow the money, may be, at an enhanced

price. But, if the same cash shortage, at that point of time

was anticipated earlier, in the course of scrutiny of cash

forecasts, he has some options open before him. He may even

decide against borrowing and may find the resources by

rearranging some phases of the operating cycle, such as,

deferring payments of bills, speedier collection of cut-

standings, postponing certain discretionary expenses or by

a combination of these measures.

The short-run financial management is built around its

two prime and inter-related ingredients, profit and cash

management. The objective of cash planning is to provide

advance signals as to:

- 11

1. What are the amounts of cash that are ineeded to attain

short-run profit objective?

2. How much of these cash requirements can be met out of the

cash generated from current income?

3. What are the magnitudes of the ebbs and flows of cash

emanating from operations, and what are the sizes and

frequencies of the resulting cash surpluses and deficits?

4* What are the sources of cash (that is, borrowing) and

and under what conditions or in what context are they

available?

Timely and rewarding short-term outlets will have to

be found for the surpluses and appropriate outside financing

arrangements will have to be made for meeting the deficit,

so that operations continue unhlndred and planned profits

are realised. Does it then mean that these situations have

only external remedies? Not necessarily. The cash planning

goals can be communicated to the operating executives and

their cooperation enlisted for realising these goals, without

restoring to external assistance. The sales division can be

requested to make special efforts to push up sales required

to generate the necessary cash. Once this sales plan is

pre-set and agreed to, the sales personnel can be relied

upon to carry it out. The collection schedules can be

reviewed and recast to yield the cash resources at the time

needed. The purchase division can, if given information on

the cash plan, rearrange its purchase schedules so as to

- 12 -

release cash for other pressing needs at specified points of

time. It is thus evident that if the advantce signals thrown

up by cash planning are acted upon constructively, a major

part of the problems of cash surpluses and deficit can be

resolved by suitable and marginal readjustments in internal

operations, without affecting the short-run profit goals.

Planning of the sources of cash will revolve mainly

around sales. If all sales were for cash, the sales

estimates themselves serve as estimates of cash Inflows.

But when cash and credit sales coexist, projection of cash

realisations from sales and debtors assumes complexity. The

sales personnel can competently aid in this planning exercise,

equipped as they are with a first hand insight into the sales

and collection patterns. The Finance Manager can, however,

exhort them to improve over past experience by planning a

higher proportion of cash sales to total sales or speedier

collection of outstandings or other measures. Cash discounts

can be planned as incentives for prompt settlement of bills,

in periods when cash inflows have to be stimulated to fore­

stall impending cash shortage. Odd transactions like sale

of disposable assets can be suitably timed to generage cash

at a time when it is needed. If the company has an adequate

holding of liquid assets, especially short-term securities,

planning for cash from operations does not have to be

disturbingly intense. A credit line with a commercial bank

- 13 -

is another major safeguard against temporary cash shortages.

But the establishment of such an external facility should

not develop as a deterrent to cash planning. It is an

expensive and not always dependable source, to be drawn upon

only in emergencies, and so the cash planning drill has to be

directed effectively to generate optimum internal resources

from operations.

The uses of cash also need to be carefully planned.

Payments to employees, inventory payments and payments for

varied services, have to be examined and forecast. Questions

such as taking advantage of cash discounts offered by

suppliers need close attention to assess and effect the

available cash savings. Besides planning the payment of

various categories of operating expenses, the payments of

taxes and dividends and the timings thereof have to be pre­

planned. The repayment of loans, in accordance with agreed

schedules, has to be provided for*

Planning Cash Balance;

It is essential that a certain minimum cash balance

is over kept ready for emergency use. The quantum to be thus

held may vary from company to company, andfrom time to time.

This reservoir of cash baianceacts as a levelling factor. It

can receive temporary excesses in cash outflow. This reservoir

cannot be allowed to go dry, as in that event, there can develop

- 14 -

a liquidity crisis and threat of insolvency. Nor can this

reservoir be allowed to fill to the brim, because it will

be expensive to hold large dose of idle cash and the return

on investment will shrink. Thus arises the question; how

much is too much? The answer will depend upon individual

business situations. The level of production, pattern of

demand, credit terms for purposses and sales, sources and

prompt availability of credit, pattern of operating expenses

etc. are factors that vary from industry to industry and

company to company. The levels of adequacy of cash also

vary correspondingly.

If excess cash is indicated in the cash plan, decision

has to be taken on appropriate utilisation by making short-term

investments, allowing some build-up in inventories, liberlising

credit, acquiring some fixed assets or repaying liabilities,

even ahead of schedule. If cash shortages are expected,

action called for may cover sale of some short-term investments,

increasing the proportion of cash sales to total sales,

aggressive collection of out standings, sale of some inventories

(though at compromised prices), sale of disposable fixed assets

and, as a final resort, borrowing funds from outside.

- 15 -

MANAGEMENT OF MARKETABLE SECURITIES:

Firms sometimes report sizable amounts of short-term

marketable securities among their current assets^ Why market­

able securities be held? The two primary reasons as a

substitute for cash and as a temporary investment:-

As a Substitute for Cash :- Some firms hold porfolios of

marketable securities in lieu of larger cash balances,

liquidating part of the portfolio to increase the cash account

when cash outflows exceed inflows. Data are not available

to indicate the extent of this practice, but our impression

is that it is not common. Most firms prefer to let their

banks maintain such liquid reserves, with the firms themselves

borrowing to meet temporary cash shortages.

As a Temporary Investment :- In addition to using them as a

buffer against cash shortages, firms also hold marketable

securities on a strictly temporary basis. Firms engaged in

seasonal operations, for example, frequently have surplus

cash flows during part of the year, deficit cash flows

during other months. Such firms may purchase marketable

securities during their surplus periods, then liquidate

these securities when cash deficits occur. Other firms,

particularly in capital goods industries where fluctuations

are vilent, attempt to accumulate cash or near-cash

securities during a downturn in order to be ready to finance

- 16 -

an upturn in business volume.

Firms also accumulate li,quid assets to meet predic­

table financial requirements. For example, if a major

modernization programme is planned for the near future, or

if a bond issue is hbout to mature, the marketable securities

portfolio may be increased to provide the required funds.

Also, marketable securities holdings are frequently large

just prior to quarterly tax payment dates.

Firms may also accumalate resources as a protection

against a number of contingencies. When they make uninsurable

product warrbnties, companies must be ready to meet any

calims that may arise. Firms in highly competitive industries

must have resources to carry them through substantial shifts

in the market structure. A firm in an industry in which new

markets are emerging for example, foreign markets-needs to

have resources to meet developments; these funds may be on

hand for fairly long periods.

- I y £ -

MANAGEMENT OF ACCOUNTS RECEIVABLE ; CREDIT POLICY

The level of accounts receivable Is determined by two

factors;

1. the volume of credit sales and

2. the average periods between sales and collections.

The average collection period is partially dependent

upon economic conditions during a recession or a period of

extremely tight money, customers may be forced to dealy

payment - but it is also dependent upon a set of controllable

factors, or credit policy variables. The major policy

variables include (l) credit standards, or the maximum

riskiness of acceptable credit accounts, (2) the credit period

or the length of time for which credit Is granted;

(3) discounts given for early payment and (4) the firm's

collection policy. We first discuss each policy variable

separately and in qualitative rather than quantitative terms,

then we illustrate the interaction of these elements and

discuss the actual establishement of a firm's credit policy.

Credit Standards;

If a firm makes credit sales to only the strongest of

customers, it will never experience bad debt losses, and it

need not incur much in the way of expenses for a credit

- \ g -

department. On the other hand, it will probably beiooslug'

sales, and the profit foregone on these lost sales could

be far larger than the costs it has aToided. Determining

the optimal credit standard involYes equating the marginal

costs of credit to the marginal profits on the increased

sales.

Marginal costs include production and selling costs,

but we may abstract from these at this point and consider

only those costs associated with the ••quality" of the marginal

accounts, or credit quality costs. These costs include

(l) default, or bad debt losses; (2) higher investigation and

collection costs; and (3) if less credit-worthy customers

dealy payment longer than stronger customers, higher costs

of capital tied up in receivables.

Since credit costs and credit quality are correlated,

it is important to be able to judge the quality of an Account

First, how should we define "quality"? Perhaps the best way

is in terms of the probability of default. These probability

estimates are, for the most part, subjective estimates, but

credit rating is a well-established practice, and a good

credit manager can make reasonably accurate judgements of

the probability of default by different classes of customers.

To evaluate the credit risk, managers consider the

five C's of credit, character, capacity, capital, collateral.

19

conditions. Character refers to the probability that a

customer will try to honour his obligations. This factor

is of considerable importance, because every credit trans­

action implies a promise to pay. Will the creditor make an

honest effort to pay his debts, or is he likely to try to

get away with something? Experienced credit men frequently

insist that the moral factor is the most important issue in

a credit evaluation*

Capacity is a subjective judgement of the ability of

the customer. This is gauged by his past record, supplemented

by physical observation of the customer's plant or store and

business methods. Capital is measured by the general financial

position of the firm as indicated by a financial ratio analysis,

with special emphasis on the tangible net worth of the enter­

prise. Collateral is represented by assets that the customer

may offer as a pledge for security of the credit extended to

him. Finally, conditions refer to the Impact of general

economy that may affect the customer's ability to meet his

obllgat ions.

The five C's of credit represent the factors by which

the credit risk is judged. Information on these items is

obtained from the firm's previous experience with the customer,

supplemented by a well-developed system of information-

gathering groups. Two major sources of external information

20

are available. This first is the work of the credit asso­

ciations. By periodic meeting of local groups and by

correspondence, information on experience with creditors is

exchanged. More formally, credit interchange, a system

developed by the National Association of credit Management

for assembling and distributing information of debtor's past

performance, is provided. The interchange reports show the

paying record of the debtor, industries from which he is

buying, and the trading areas in which his purchases are

being made.

The second source of external information is the work

of the credit-reporting agencies, the best known of which is

Dun & Bradstreet. Agencies that specialize in coverage of

a limited number of industries also provide information.

Representative of these are the National Credit Office and

the Lyon Furniture Mercantile Agency. These agencies provide

factual data the credit manager can use in his credit analysis,

and the agencies also provide ratings similar to those avai­

lable on corporate bonds.

An individual firm can translate its credit information

into risk classes, grouped according to the probability of

loss associated with sales to a customer. The combination

of rating and supplementary information might lead to the

following groupings of loss experience.

Risk number Loss ratio class (in percentages)

1 None

2 0 - y2

3 y 2 - 1

4 1 - 2

5 2 - 5

6 5 -10

7 10 -20

8 Over 20

If the selling firm has a 20 percent margin over the

sum of direct operating cost and all delivery and selling

costs, and if it is producing at less than full capacity, it

may adopt the following credit policies. It may sell on

customary credit terms to groups 1 to 5; sell to groups

6 and 7 under more stringent credit terms, such as cash on

delivery; and require advance payments from group 8. As

long as the bad debt loss ratios are less than 20 percent,

the additional sales are contributing something to overhead.

Statistical techniques, especially regression analysis

and discriminant analysis, have been used with some success

in judging credit worthiness. These methods work best when

individual credits are relatively small and a large number of

borrowers are involved. Thus, they have worked best in retail

'̂ 2

credit, consumer lo^ns, mortgage lending, and the like. As

the increase in credit cards and similar procedures builds

up, as computers are used more frequently, and as credit

records on individuals and small firms are developed, statis­

tical techniques promise to become much more important than

they are today.

Terms of Credit;

The terms of credit specify the period for which credit

is extended and the discount, if any given for early payment.

For example, if a firm's credit terms, to all approved

customers, are stated as "2/10, net,30, this menas that a

2 percent discount from the stated sales price is granted

if payment is made within 10 days, and the entire amount is

due 30 days from the invoice date if the discount is not

taken. Terms of "net 60" indicate that no discount is

offered and the bill is due and payable 60 days after the

invoice date.

If sales are seasonal, a firm may use seasonal datings.

Jensen, Inc., a bathing suit manufacturer, sells on terms of

"2/10, net 30 May 1 dating". This means that the effective

invoice date is May 1, so the discount may be taken until

May 10, or the full amount paid on May 30, regardless of

when the sale was made. Jensen produces output throughout

the year, but retail sales of bathings suits are concentrated

'> ' 1

in the spring and early summer. Because of its practice

of offering seasonal datings, Jensen induces some customers

to stock up early, saving Jensen storage costs and also

"nailing down sales".

The Credit Peirod Lengthening the credit period

stimulates sales, but there is a cost to trying up funds in

receivables. For example, if a firm changes its terms from

net 30 to net 60, the average receivables for the year might

rise from $ 100,000 to $ 300,000 with the increase caused

partly by the longer credit terms and partly by the larger

volume of sales. If the cost of capital needed to finance

the investment in receivables is 80 percent, then the marginal

cost of lengthening the credit period is $ 16,000

( = I 200,000 X 8 percent). If the incremental profit - sales

price minus all production, selling, and credit costs asso­

ciated with the additional sales-exceeds $ 16,000, then the

change in credit policy is profitable. Determining the

optimal credit period involves locating that period where

marginal profits on increased sales are exactly off set by

the costs of carrying the higher amount of accounts receivable.

Cash Discounts;- The effect of giving cash discounts may be

given an analysis similar to the one used for the credit

period. For example, if a firm changes its terms from "net 30"

to "2/10, net 30", it may well attract customers who want to

take discounts, thereby increasing gross sales. Also, the

average collection period will fall, as some old customers

will pay more promptly to take advantage of the discounts.

Offsetting these benefits is the cost of the discount, taken.

The optimal discount is established at the point where costs

and benefits are exactly offsetting^

Collection Policy; Collection policy refers to the procedures

the firm follows to obtain payment of past-due accounts. For

example, a letter may be sent out when the account is 10

days past due; more severe letter, followed by a telephone

call, may be used if payment is not received within 30 days;

and the account may be turned over to a collection agency

after 90 days.

The collection process can be expensive in terms of

both out-of-pocket expenditures and lost goodwill, but at

least some firmness is needed to prevent an undue lengthening

in the collection period and to minimize outright losses.

Again, a balance must be struck between the costs and benefits

of different types of collection policies.

Accounts Receivable Versus Accounts Payable; Whenever goods

are sold on credit, two accounts are created-an asset item

entitled an account receivable appears on the books of the

selling firm, and a liability item called an account payable

appears on the books of the purchaser. At this point, we are

analyzing the transaction from the view-point of the seller,

so we have concentrated on the types of variable under his

control. Later, in Chapter

FINANCING OF WORKING CAPITAL

There are two major sources short term and long term

through which the firms current assets are financed. Trade

credit and cash credit (short term commercial bank loans)

are the two primary sources of financing working capital

in India. For every item of working capital, specific

source is suitable. Current assets or variable or temporary

working capital should be financed by short terra credit,

those assets assets which are less liquid should be financed

from long term funds. John, J. Hampton has given three

guidlines for financing working capital:

1. Guidelines 1 : permanent and variable working capital.

The sources of funds are compared against the firm's

permanent and temporary working capital. The remainders

of the permanent working capital plus all the fixed assets

should be financed from long terms sources.

2. Guidelines 2 : Major current - Asset Accounts cash and

receivable are the most liquid assets and are or will soon

be available to pay bills. There may be matched against

current liabilities.

Guidelines 3 : Total current Assets. A 2/l normal current

ratio means that one half the current Assets will be matched

against short-term liabilities. The remaining current assets

and all fixed assets will be financed by long terms sources

of funds.

Advantages of long & short term sources of working

capital are i.e. :

1. Lower Costs; 2. Establishers close relations with banks,

(i) Reduces Risk, (ii) Provides stability and (iii) Increases

Liquidity. Bjjnk loans and trade credit together finance

about 3/4 of the working capital requirements of industry.

The banker, after scrutiny on the lines suggested by the

Reserve Bank of India determines the maximum line of credit

permissible for the period based on the margin requirements

of the security offered. The margin is the percentage of

the value of property offered as security by the firm which

has to be financed by the firm itself. For example, If the

banker insists on a margin of 30^ on a particular item of

inventory worth Bs.1,00,00, it means the banker will finance

it upto 8s.70,000 (70^) and the balance of Bs.30,000 will

have to be provided by the firm. JPlie margin is based on

the nature of the goods.

After getting the overall credit limit sanctioned by

the banker, the company actually draws the fund needed from

time to time (subject to the margin stipulation) using any

or all the following forms of credit:

9 7 hi i

i

A. Laon Arrangement : Under this arrangement the entire

amount of loan is credited by the banker to the party's

account. Interest is payable on the entire amount, or

when loan is repaid in instalments on the actual balances

outstanding.

B, Overdraft Arrangement : Under the arrangement the party

is permitted to overdraw on his current account with his

banker upto a stipulated limit. There are no restrictions

on the number of drawings within that limit* Repayments

are permitted as and when desired during the period. Inte­

rest is charged on the amount actually utilized. These

facilities are not available in a loan arrangement.

C, Cash Credit Arrangement : It is operated in the same

way as a current account in which an overdraft has been

sanctioned. The company may operate his account as and

when required within the stipulated limit and can save

interest by reducing the debit balance. However he has to

pay a commitment charge of 1% on the balance unutilized

during the period. Cash credit is usually allowed against

pledge or hypothecation of goods and the borrower can

provide alternative securities from time to time in confir-

mity with the terms of advance.

D. Term Loans for WC : Under this arrangement the borrower

can obtain a loan for a period of 3 to 7 years and repay the

\j ^ amount in yearly or half yearly instalments

hi 0

E. Bill Parchases and Bills Discounted : Sight bills, clean

or documentary are purchased by abankers and usance bills

are discounted. Whether bills are purchased or discounted,

the amount made available under this arrangement is covered

by the cash credit and overdraft limits. Before buying or

discounting the bills the banker satisfies himself as to

the credit worthiness of the drawer and the genuineness

of bills.

Commercial establishment now a days working with

borrowed capital. Borrowing is mainly from commercial banks

for working capital at a cost of 18% rate of interest per

anum. The profit generated during a year is ploughed back

in the business and rarely it is used either for repayment

or lowering down of working capital loans or other loans.

F» Export Finance : The exporter can apply to his banker

"packing credit" which is short term advance granted by banks

to exporters for assisting the exporters in buying, processing,

packing and shipping the goods. The period of packing credit

is normally 90 days. In special cases it is extended upto

240 days. A concessional rate of interest of Q% is charged

on such advances. Any advance granted under this facility

is to be liquidated by negotiation or purchase of the

export bill covering the particular shipment for which the

packing credit has been granted. If the export bill is drawn

in a foreign currency, the exporter is require to sell forward

29

the foreign exchange to the bank so as to avoid risks in-

TolTed in a possible change in foreign exchange rate.

s In obtaining the commercial bank credit, the Tariou

modes security used are :

1. Hypothecation : It is mortgage of movable property.

Under hypothecation, money is borrowed by the owner of goods

on the security of movable property (usually inventories)

without parting with the possession of movable property.

The rights of the hypothecatee depend upon the terms of the

contract between the parties. He can always file a suit

to realise his dues by sale of the goods hypothecated.

Creditor can not have prefential claim in the event of

insovency of the Borrower. Although advances against

hypothecation of goods are riskier than advance against

pledge of goods, the possibility of losses through dis­

honesty of borrower is very small.

2. Pledge : It is a kind of bailment by which one person

transfers possession of some article to another for securing

the payment of debt. The bailer is called "pawnor" and the

bailee the "pawnee". Deposit of goods as security for a

loan is essential. No pledge is created if there is no

transfer or possession of goods. The pawnee is required

to take reasonable care of goods pledged with him. He must

not use the goods pledged and would be responsible for any

loss or damage, if he does use them. The pledge lien

30

gives the pledgee the right to sell the goods in the event

of the non-payment of the debt. The letter of pedge

specifies the terms and conditions on which an advance is

made, it is in the nature of a special agreement and modi­

fies the rights the pledger has under the law to the extent

required by the bank. Most of the clauses in the letter of

pledge are in corporated as a result of practical difficulties

experienced by banks from time to time.

3. Lien : It is the right of retaining goods belonging to

another until a debt due to him is paid. Possessory lien

is of two kinds : particular and general. Particular lien

is a right to retain goods until a claim pertaining to

those is paid. General lien can be applied until all claims

of the possession are satisfied. Bankers enjoy general lien.

4. Mortgage : It is the transfer of interest in specific

immovable property for securing the payment of money advanced.

The mortager parts with an Interest in that property in

favour of the mortgagee. Mortgage is not a mere contract,

it is the conveyance of interest in the morrgaged property.

The mortgagee's interest in the mortgaged property is

terminated as soon as the debt is paid. The mortgager has

the right to redeem or regain the property after pay off

the debt.

5. Charge : Where immovable property of one person is by

the act of parties or by operation of law made security for

payment of money to another, and the transaction does not

amount to mortgage, the latter person is said to have a

charge on the property and all the provisions applicable

to simple mortgage will apply to such a charge.

That is:

(a) a charge is not the transfer of interest in the property

though it is security for payment. But a mortgage is a

transfer of interest in the property,

(b) a charge may be created by act of parties or by operation

of law. But a mortgage can be created only by the act

of parties,

(c) a charge need not be made in writing, but a mortgage

deed must be attested,

(d) generally, a charge cannot be enforced against a

transferee for consideration without notice. But in

a mortgage the transferee of the mortgaged property

can acquire the remaining interest in the property, if

any left.

Long-term Capital:

We can make arrangements for the long-term capital

required by an industry with the following:

1. Issue of right shares

2. Issue of preference shares

3. Issue of debentures.

'5 ••!

Internal Sources of Funds;

There are some internal sources to meet out the

demands of funds required for day-to-day operations.

There are the following sources;-

1. Retained earnings

2. Depreciation

3. Sales-tax collected but did not pay to the Government

This fund we can keep for two to three months till

submission of returns.

4 . E m p l o y e e ' s d e p o s i t / S .

STUDY OF ABC RUBBER COMPANY LIMITED

MANAGEMENT OF CASH

EXISTING SYSTEM OF CASH FLOW'.

Proforma of Cash flow has been attached in Annexure

SALES REALISATION-SOURCES OF INFORMATION;

All Divisional Managers Sales are asked to give the

sales and collection of money during the month. They are

also asked to give the outstanding receivables at the

opening of month and at the end of the month. They provide

these figures on the basis of goods allocated to their

Division by the Coordination Manager Sales which takes the

decision in the Sales Meeting which is held every month to

review the Sales position.

DRAWBACK;

Divisional Managers are asked to give these figures

on the first day of every month. Upto that date they did

not know the position of goods allocation to their respective

Divisions. So they give these figures on their own estimates

which some times have variance from actual sales. Even the

figures of outstanding receivables are generally not correct

because Divisional Managers can not get the actual figures

from their depots upto that date because depots are situated

at distance places. So we see these figures can not be taken

as very reliable. A small rariance can cause the disruption

of payment programme.

SUGGESTIONS:

My suggestions to this situation is that sales meeting

should be held by Ilnd day of each month and DiTisional

Managers should be asked to give the sales and collection

forecast by 4th day of every month. By this date they can

also collect the figures of actual outstanding receivables

from their various depots. This will give authentic esti­

mates and there will not be much variances. Cash flow can

be prepared from 5th of every month of 4th of next month,

this will give us more accurate picture of our sales

collection and seeing the outstanding figures we can also

plan the credit sales and cash sale policies.

PAYMENTS?

1. EXCISE DUTY; This payment can not be postponed or altered,

If we have to sell our goods we will have to give the excise

duty. If it deposited well in advance in the Government

Accounts. So Excise Duty payments are made on Top Priority

basis .

There is no drawback in this system. According to

daily despatches programme excise duty is deposited in the

Bank.

Or)

2. RAW MATERIALS; In Rubber Industry raw materials are

very costly. In a company which produces 4,00,000 tyres,

tubes and flaps annually about Rs.3,00,000/= worth of raw

material is required for every month. This is a big amount.

Some materials are of vital nature and can not be procured

immediately. Some imported raw materials take 4 to 6 months

in procurement. They have to be planned well in advance

and their payments can not be posponded.

Suppliers send their bills to the costing department

which after passing them send to the Head Office account,

where they are immediately paid to the suppliers. For cash

flow purpose apyment programme is given by the Purchase

Manager to the Accounts department.

DRAW-BACKS;

Payments are immediately made by head office as soon

as they receive the credit vouchers from the costing depart­

ment. Credit facilities are not availed generally from the

creditors. Some material can be procured within 3-4 days

because of local availability of the material. Payment is

made by draft.

SUGGESTIONS;

Every supplier must give some credit facility to

accomodate the company. Payment must be made after the

expiry of credit period. Payment must be made by local

cheques only so that some interest can be saved in the

bank on account of cheques issued but not presented for

payment.

Purchase department prepares the payment programme on

the basis of supplies made by the suppliers. Some payments

can be postponed for subsequent periods and only most important

payments should be made in Company has some financial diffi­

culty,

POWER AND FUELt

These figures are supplied by factory people. These

are mainly based on the running schedule of the plant. We

found these figures completely authenticated. There is no

need of any alteration in this. These payments can not be

avoided or postponed as these things affect the production.

SALARIES AND WAGESt

These figures are taken on the actual basis. Generally

these are only permanent staff and every month same amount

is paid as wages and sales.

These payments can not be postponed and being made in

the first week of every month.

In the existing system of company we find that salaries

to all staff are being paid in cash. Our suggestion is that

??, D. uivadmam J Ph.D. PROFESSOR Department of Business Administration University of Rajasthan

T«i w„ Office : 60271 Ext. 318 ' ®'- ^°- Res. ; 68775

B-38, Prabhu Marg, Tilalcnagar, JAIPUR—302004

Dated 12tlt April jpg2

Tke Assistant Registrar, (Examinations), Aligark Muslim University, AligarJa

Dear Sir, I am sending herewith tv»o dissert.-itions duly

examined by me as per V.P.P, as provided for in your rules. Tke amount of V.P.P. is accounted for as under \

1. Register-d iet,:;er cont:aining award list

2. " " to Asstt. Registrar 5. V.P. Parcel containing dissertations

3=35 3=20

13=25

Total postal ckarfes 19=80

Tkanicing you,

E n d . i Two postal r ece ip t s .

Your|e^ t ru ly ,

(DrI R.B. UpaciJyaya)/

0 (

salary of the persons who are getting more than fe,1000/= as

salary should be given payment only by accounts payee cheque

By using this way company can also save some interest amount

as these cheques will be presented for payment only after

one or two days.

CONSUMABLE STORES:

These figures are supplied by commercial Manager who

is the incharge of stores. They have a very good store

purchase storage and store accounting system. Every month

about Iils.8 lakhs worth of stores are consumed. For imported

items they plan well in advance. Some materials are also

being procured from local market. They have computerized

control on store accounting. We do not see any fault in

their existing system.

INSURANCE:

How much amount is to be paid to the Insurance Companies

for the insurance of factory building, machinery and stocks

of finished goods and raw materials, these figures are given

by the Insurance Department which has experienced.personnels.

These figures are counter checked by the Accounts Department.

These payments are made on their due dates and can not

be avoided for more than a week's time becuase there is

always a risk of fire etc. We find these figures completely

authent icated.

'•4'3 t)0

ADMINISTRATIVE MANUFACTURING & SELLING EXPENSES:

These figures are given by the factory accounts

department and as well as by various departments of the

head office. These figures are based according to the

policies of the management. Generally budgets are fixed by

the Managesent.

DRAW BACKS!

We have finding in this head there is not much control

on expenses. Some departments incur heavy expenditure as

Conveyance, Travelling and Staff Welfare expenses. There is

no special checking on these expenses. Management never

sees what is being spent on these heads except on several

occasions.

SUGGESTIONS;

My suggestions in this area is that Management should

have more control on these expenses. Every month about

Ks. 32 lakhs are spent under this head. There are so many

areas where expenses can be curtailed. If even one lac

rupees can be saved in a month this will be a big achieve­

ment. Advertisement expenses can also be decreased if our

sales are very high and we have lion's share in the market.

Unnecessary telephone expenses can also be avoided by using

call registers.

9

DEPOT'S EXPENSES;

Every month about 8s.15 lacs are being spent for running

the various depots which are situated in the major cities of

India. These figures are supplied by the various Divisional

Managers.

DRAW-BACK;

Head office has not a good control on Depot expenses.

The major draw-back is that depot accounts are being audited

by local auditors and management can not know the actual

expenses incurred by the depots. Although Head Office

receives expenses reports and statements from the depots

every month but there is no authenticity in the figures of

some items. Like on Laoding and Unloading a huge amount is

charged every month which does not provide proper receipts

etc.

SUGGESTIONS;

My suggestions in this area is that Head Office after

closely checking the requirements of the depots, should

fix-up the targets for the expenses of these depots and

only Budgeted amounts should be sent to depots for expenses.

If they require some additional funds for any specific

purposes they can be sent after the approval of the Management.

Our second suggestion in this area is that some senior officers

4d

of the company should visit the depots without informing

them prior of the visit and he can checkup the various

expenses incurred by them on the spot. If we could save

only Bs. 50,000/= to Rs.75,000/= per month in this head this

will increase our profit and there will be more effective

control on the depots.

Interest; This is the major expenditure head of the company.

Being a Capital based project it had to borrow about 8s.16

crores from various Banks and financial institutions and

about Ks.7 crores has been taken from various banks as working

capital. Besides this, certain other loans have also been

taken to meet the over run requirements. This has caused

heavy payments of interest every month. These figures for

cash flow purpose are supplied by Accounts department of

site and Head Office.

DRAW-BACK & SUGGESTIONS:

There is no major draw-backs in the payment programmes.

But it is suggested that some times if company is facing

temporary financial crisis it should approach to the Financial

Institution for the deferment of payment of interest. Under

these circumstances, the financial institutions can give due

consideration to the difficulties and allows the deferment

without imposing any penalty or overdue interest. This can

fulfil the gap temporarily working capital requirements.

4i

And second suggestion is that company should try to

repay the laons as early as possible by curtailing unneccessary

capital expenses and various over heads to minimise the

interest liability which in turn would result in increased

profits.

LOAN REPAYMENT:

These figures are provided by Accounts Department. If

we are short of funds we can ask the Banks and financial

institutions for the deferment of these payments but if we

are in a position to pay the laons we should affect these

as this will save us from the high interest liabilities.

SALES TAX;

Every month about Bs.80 lacs is collected by various

depots under this head. Payment figures of Sales Tax are

supplied by Taxation Department. These are based on the

actual reports and statements of sales received by them

from various Depots.

Sales tax collected provides the temporary working

capital. Because in some States Sales Tax payments are

made on monthly basis and in some states on quarterly basis

so upto that time we can use that money as per out require­

ments. These payments can be postponed for some time if we

are short of funds. Generally Sales Tax Officers accomodate

in such situations.

i 0 4^

ROYALTY; Payment of Royalty is made every Quarterly. On

the sales of the company. There are various legal for this

payment. This payment can be dfered for some time if we are

short of funds. This is not such an urgent payment.

SECURITY REFUND: Every month some amount Is refunded to

various dealers as security refund. This constitute only

about RS.50000/= or Rs.75,000/= in a month so there is no

problem in paying this amount.

CAPITAL EXPENSES; Every month about B5.20 lacs is being spent

on the purchase of various imprted and indegenous machine^

and spare parts and on building wrk. These payments

represent the extension programme of the company. These

are made on the availability of funds. Figures for these

payments are supplied by Plant Manager.

FIXED DEPOSIT REFUND : Every month about Bs. 5 lac is being

refunded to the Fixed Depositors. These payments can not be

avoided and company makes them in time to earn the good name

among investors.

GENERAL: Thus we see various payment figures are given by

various department hhich are compiled by Accounts Section

at Head Office and they write these figures in the column

of payment asked for. In the first column figures given

by Costing Department are written. These are based on the

production programme. In the third column Expected Payments

43

are written. These are prepared by Accounts department

subject to the aYailability of funds and as per Sales

Realisation Programme. Surplus or Deficit figures are

calculated and are being given in the cash flow statement.

SUGGESTIONS;

It is suggested new proforma for the cash flow which

has been enclosed in this report as Annexure No.2. In this

proforma Receipts and Payments will be shown on weekly basis.

By using this we would be able to know our weekly surplus

of deficits and Payment programmes can be replanned according

to the availability of the funds. We found that no compara­

tive statement is being prepared by the company at the end

of the month. We suggest that at the end of the month Actual

Receipts and Payments should be compared with the given

figures and reasons of variences should be seen closely so

that next time there should not be any difference.

- 44 -

ABC CO. LTD.

CASH FLOW FOR THE MONTH OF

(BS. in lacs)

As per pro­duction pro- Payment Payment Actual Exp. for gramme for asked for expected last month current month

es Realisation

er Receipts

al receivables MENTS ise Duty Material er & Fuel aries & Wages sumable stores urance inistiatlve Ex. ot Expenses . & Selling Ex. erest erest n Repayment es Tax alty urity Refund ital Expenses ed Deposit und ome Tax

AL PAYABLES

plus (Deficit)

k Balances as 1st day of th

sing Balnce at e end of the th

qus issued but presented

CURRENT ACCOUNTS

- 45 -

ABC C0» LTD»

CASH & BANK BALANCE REPORT AS ON REPORT NO

NAME OF BANK OPEN'IXG RECEIPT/ BALANCE INTER BANK

TRANSFER

DISBURSEMENT BALANCE

Punjab National Bank

State Bank of India

Allahabad Bank

Syndicate Bank

India Bank

P & S Bank Ltd.

Cash in Hand

TOTAL

CASH CREDIT ACCOUNTS

NAME OF THE BANK SANCTIONED LIMITS AVAILED BALANCE

State Bank of India, Bombay State Bank of India,New Delhi City Bank N.A., New Delhi P.N.Bank, New Delhi P.N. Bank, Bombay Stqte Bank of Patialia

^ G. TOTAL Stock of Raw Material Cheques issued but Stores, spares, and Goods bot presented for in process and Govt.Book Debts. payment Rs.

Stock of Finished Goods. At plant Rs At Depots Ss

TOTAL

Balance D.P. available Ss

Prepared by Accountant Controller of Accounts Finance Manager

- 46 ~ ABC CO. LTD. ANNEXURE "B'

CASH FLOW FOR THE MONTH OF

Payment Payment 1st Week Ilnd Week Ilird IVth Actual asked for expected 1-8 9-16 Week Week for last

17-23 24-31 month

Sales

Realisation Other

fieceipts

Total

Receipts

Exise Duty

Raw Material payments

Power & Fuel

Salaries & Wages

Consumable Stores

Insurance

Administrative Ex.

Depot Expenses

Manufacturing & Selling Exp.

Loan Repayment

Interest

Sales Tax

Royalty

Security

Refund

Capital Exp.

Fixed deposit Refund

Income Tax

Others

Total

Payments

- 47 -

ANNEXURE "B" CONTD.

Payment Payment 1st Ilnd Ilird IVth Actual asked expected Week W6ek Week Week for last for 1-8 9-16 17-23 24-31 month

Surplus/ deficit per week

cumulative

Bank balance as on 1st of this month

Closing balance

- 48 -

ABC CO. LTD.

SALES REALISATION FOR THE MONTH OF

TARGET 1st Week Ilnd Week Illrd Week IV Week Actual for FOR THE last month MONTH

U.P. Zone

North Zone

East Zone

South Zone

West Zone

Export

Others

Total

INTEREST PAYMENTS

Total amount 1st Week Ilnd Week Illrd Week IVth Week Actual for

last month

Terms LoansSBI

DBI

IFCI

TI

ICICI

LTC

UP.GOVT.

P.N.Bant

State Bank

City Bank

Working Capital

P.N. Bank

S t a t e Bank

C i ty Bank

S t a t e Bank of P a t i a l a

Others

Raw Mat.

Promoters

ethers Total

- 49 -

ABC CO. LTD.

DAILY COLLECTION STATEMENT Dated,

SI. Name of Collection Collection Collection Collection No. Depot to-day todate of target todate of

this month todate of previous month this month

1. 2. 3. 4. 5.

6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 2t.

Kanpur Lucknow Vasanasi Agra Direct Receipt at site and Head Office

Delhi Simla Jammu Jaipur Chandigarh Patna Calcutt a Gauhat i Hyderabad Bangalore Madras Cochin Ahmedabad Bombay Indore Nagpur Goa Export

Total Sales Realisat ion

repared Accountant COA Finance Manager

CC : Vice Chairman, Executire Director, President, ACOA, UP Zone, North Zone, East Zone, South Zone, West Zone.

- 50 -

WORKING EXPENSES FOR THE MONTH OF

( fe. in Lacs)

Factory Head Total 1st Ilnd III IVth Jctual for Office Week Week Week leek ^̂ '̂ ^^^* """^^

A:

El ch

Power & fuel

ectricity arges

Coal & its freight

Sub Total

B:

C:

D;

EJ

Salaries & Wages

Consumable Stores

Insurance

Administra-tions, Mfg. & Seeling Expenses Freight on Raw Material

Freight on Sales

Advertise­ment

Selling Expenses

Repairs & Maint.

Travelling Exp»-

Staff Welfare Expenses

Total Exp.

P. & T.

TOTAL

- 51 -

ABC CO. LTD.

DISBURSEMENT & RECEIPT STATEMENT Dated

SL. NO.

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

14.

PAYMENTS TODAY

Excise Duty

Raw Material

Working Expenses

Depot Expenses

Sales Tax

Income Tax

Interest

Capital Expenses

Loan Repayment

Royalty

Security Refunded

TODATE THIS MONTH

TARGET TO DATE pSFV^mrr OF THIS MONTH MONTH

TOTAL PAYMENTS

TOTAL RECEIPTS AS PER DETAILS ATTACHED

Prepared by Accountant C o n t r o l l e r of Accounts Finance Manager

- 52 ~

MANAGEMENT OF INVENTORY;

Inventory is defined as goods in possasion for resale.

Inventories may be durable, or nondurable, pereshable or

non perishable, valuable or in enexpensive. Inventory policies

have a direct and important bearing on the financial needs of

the firm.

Inventory constitutes the major element in the working

capital of any business undertaken. RBI made a study of 1650

companies in the year 1973-74 and have found that inventories

constitute about 37% of the investment in current assets. The

major portion of current assets is invested in inventories

and, therefore, inventory management has a significant role

in the working capital management.

In U.S. Income-tax data from the Internal Revenue

service show that inventories average approximately 20% of

a manufacturing firm's total assets. For retail firms, the

figure is closer to 30 percent. Every industry either it is

small or big has to keep inventories. The ideal method of

working is not to have any inventory, but that is impossible.

No trading or manufacturing business can be run without

keeping any inventory. Inventory may be low or big but always

remains there.

- 53 -

NEEDS TO HOLD INVENTORY;

(1) To make availability of materials required for production

for maintaining smooth flow of production operation.

(2) To get benefit of low price or discount on bulk purchases,

(3) To meet an ever increasing demand for prompt customers.

(4) To keep hold on certain vital or critical supplies such

as spares and tools without which production is stopped.

(5) To minimise costs and maximise profits.

(6) To promote flexibility in plant scheduling

{7) To maximise sales and take highest market share

(8) To manufacture goods in economic production runs

The inventory policy of the company have a direct

effect on the financial needs of the company. In view of

changing inventory decisions and policies the funds position

of the company will also undergo changes. It is, therefore,

very essential to keep the inventory under constant review.

To summerise the benefites to a firm are avoiding coss of

sales, gaining quanlity discounts reducing order costs:-

Here are some objectives of controlling the inventory:-

1. To control the capital investment

2. To control the inventory carrying cost

3. To control the re-ordering cost.

In a manufacturing concern there are generally four

type of inventory:-

- 54 -

1. Raw Materials

2. Goods in process or working process.

3. Finished goods

4. Stores and spares

RAW MATERIAL - MANAGEMENT;

Raw material are those goods that have not yet been

committed to production in a manufacturing firm. For each

manufacturing concern raw materials are required. As production

is nothing but a conversion of raw materials to finished goods

with the help of certain processes. In inventory, raw materials

play a vital role, as maximum cost of inventory is blocked in

raw materials. For example, in Modi Rubber Limited, an

automobile tyres and tubes manufacturing plant, stocks of raw

materials both in stock and transit remains to the tune of

about fe. 4 crores against the total inventory of Bs.10.5 crores.

It means about 38^ inventory is of raw amterials only against

the total inventory.

To keep proper control over the inventory of raw

materials, it is very much essential that stock levies of

raw materials should be kept as minimum as possible keeping

in view the all aspects of continuous supply of raw materials,

inventory carrying cost, re-ordering cost and stock-out cost.

For example of a ABC Comapny Ltd. where material A which is

the main raw material is used about 32 Tons per day carrying

a cost of Bs.2.5 lacs. The purchasing point of this raw

- 55

material is Cochin. The minimum stock lerel of this raw

material is kept for 10 days stock in store and 17 days stock

in transit. This level is fixed with a view that from Cochin

to site, transit period by rail is about 15 days. There is a

continuous supply of wagons from Cochin on production sche­

duling basis. This company in practical keeps the stocks of

this particular item about 12 to 13 days which is also a maximum

level fixed by the company. Some times, this maximum level is

crossed due to the following two reasons :-

1. Change in production programme

2. Some times, wagon despatched from Cochin does not reach

site in time due to some unavoidable circumstances and

to avoid any shortage of material fresh lot is sent in

place of that consignment. Some, it has been experienced

that both the consignments reach together with a gap of

one or two days. In that case inventory goes high and

is to be control by stopping that much quantity to despatch.

This company also tried to keep minimum stock of this

item for eight days but that was not feasible as it has

happened many a times particularly incase of railway strike

that this material had to procure by road transport. The

transit time by road is 7 to 8 days but in practical way,

sometimes truck are held up and reach site in 9 to 10 days.

Therefore, to avoid any stock-out position, this comapny has

kept minimum stock level of this Item for 10 days.

- 56 -

For fixing of stock level of raw material, many points

are to be kept in view like :-

1. Source of supply

2. Either supplier is one or more suppliers

3. Production of that supplier in case of one supplier

4. Other users of that particulars raw material

5. Our share out of that production

6. Production scheduling of that supplier and our production

scheduling

7. Transit time

For example, in ABC Company Ltd. raw material named

•B' is used about 8 Tonnes costing Bs.90,000/= per day. This

raw material is supplied from such centre urtiere transit time

is less than one day. But you will be surprised to know that

minimum stock level of this raw material is to be kept 30 days

in store. Why it is so? Why inventory is held up for

Bs,27 lacs which can be kept in ideal way 4 to 5 days i.e.,

for Rs.4.50,000/= the reason is:

1. Supplier is one

2. That particular type of material is produced by that

supplier once or two times in a month.

Though the transit time is one day but we have to

keep in every condition 30 days stock with a view that if

that particular batch of material is manufactured only last

- 57 -

the month that can reach factory before stock-out position.

Therefore though there are some specified system to keep

minimum and maximum stock level, but in practical life, these

are also viewed with the other prevailing factors like in

case of 'B' category raw material of ABC Oompany Limited.

MANAGEMENT OF WORK^IM-PROCESS INVENTORY

The work-in-progress inventory or goods in process

are those materials that have been committed to the manu­

facturing process but have not been completed. In other

words goods are not yet ready to sale.

The work-in-process inventory in an industry is a

function of the manufacturing technology, that is whether

the industry is of a continuous process type or a batch

production type. In the case of the continuous process the

value of work-in-process inventory is generally fixed and

in depends on that particular process and/or the capacity

of the machinery i.e., how much material is in the machine

under the process stage. An example of this type of pro­

duction might be nylin, fertilizers and oil refineries. On

the other hand in firms which are employing'batch process'

type of production process the work-in-process inventory

can vary significantly a discussion of three salient aspects

of the 'batch process' work-in-process inventory management

f01 lows:-

- 58 -

PROCESS REQUIREMENT

Problem Definition/Choice of Decion paths

Many industries have some technological character­

istics which require that the processed material be used

immediately of other some aging process the tyre industry

is one such industry. There is always a miximum time which

any in-process-material can be kept bfore the quality of

the material deteriorates with the passage of time. In the

typical case of the process for manufacturing tyres the

minimum and maximum time required for the mixed rubber

compound are fixed. The minimum time is equal to the aging

time which must be completed before the next process on the

same material can take place. The maximum limit is the

time before which it should be consumed in order to prevent

over aging and deterioration in quality. In the case of the

rubber industry, the minimum aging time is four hours and

the maximum is 24 hours. Similarly, in the case of Alcoholic

drinks manufacturing industry, it is seen that the quality

of the Alcohol being produced improves with the passage of

time. Whatever may be the situation it would depend upon

the type of industry but it is clear that the management

has a task before itself to see that the limits are maintained

within minimum and maximum levels so that the ultimate

objective of control over work-in-process inventory is

achieved.

- 59 -

COST OF

Problem Definition ; General impression in the mind of people

is that industry having minimum work-in-process inventory is

most efficiently run undertaking. If sophisticated machines

are being used then objective should be to optimise the

following costs, as a unit, and not separatelys-

a) Machine setting up cost; and

b) Inventory carrying cost.

It will be seen if the number of set ups of a machine

is increased then set~up cost will increase while inventory

carrying cost will come down. On the other hand if the

number of set-up is low then the setting up cest will be low

but the Inventory Carrying Cost will increase, therefore

the objective should be to minimize the total cost which is the

arithematic sum of the two cost.

DATA:

Name of Machine = A

Product produced = X

Cost of setting up raachine= Bs.500/=

Number of X required/day = 200

Daily inventory

carrying cost = 8s.0.50

Production requirement = 1000 pes

- 60 -

ANALYSIS;

No. of set-ups = 1

Inventory at the end of first day = 800

Inventory at the end of second day = 600

Inventory at the end of third day = 400

Inventory at the end of fourth day = 200

Total cost (when number of set-ups is the minimum i.e., l)

= Set up cost + Inventory carrying cost

= No. of set-ups X set-up cost + number of pieces x Daily inventory carrying cost

= 1 X 500 + 800 X 0.5 + 600 x 0.5 + 400 x 0.5 + 200 x 0.5

= 500 + 400 + 300 + 200 + 100 = Bs.1500

Total cost (when No. of settings is maximum i.e., 5)

= No. of setting x setting up cost + No. of pieces x Daily

Inventory carrying cost

= 500 X 5 + 0 x 0 . 5 + 0 x 0 . 5 + 0 x 0 . 5 x 0 x 0 . 5

= Rs.2500

This point clarifies that the objective of the

management should be to minimise the setting up cost as well

as inventory carrying cost rather than only minimization of

inventory management policies also have significant influence

on the investment in working process inventory. From the

abovementioned case, it is clear that the total cost in

- 61 -

s e t t i n g up as w e l l as i n v e n t o r y c a r r y i n g c o s t i s e q u a l t o

8 s . l , 5 0 0 / = a g a i n s t t he t o t a l s e t t i n g up c o s t of 8S.2500/= i f

t he machine i s s e t up on d a i l y b a s i s . T h e r e f o r e r i g h t

a l t e r n a t i v e i s t h a t X s h o u l d be p roduced and s t o r e d r a t h e r

than s e t t i n g up machine on d a i l y b a s i s .

I t means t h a t s t o c k in w o r k - i n - p r o c e s s d i f f e r s from

company to company. I t i s more b a s i c a l l y depends upon t h e

p r o c e s s s y s t e m . Moreove r , e f f o r t s s h o u l d be made t o keep

t h e i n v e n t o r y as minimum as p o s s i b l e keep ing i n v iew t h e

a l l o t h e r f a c t o r s l i k e machine s e t - u p c o s t e t c . e t c .

I n v e n t o r y of w o r k - i n - p r o c e s s a l s o goes h i g h somet imes

or becomes low somet imes due t o p r o d u c t i o n s c h e d u l i n g . Some­

t ime a c t i o n s t h a t speed t h e p r o d u c t i o n p r o c e s s may i n c r e a s e

out pu t w i t h o u t p r o p o t i o n a t e l y i n c r e a s e in t h e w o r k - i n - p r o c e s s

i n v e n t o r y . On the o t h e r hand the f i r m s w i t h n o t good p r o d u c t i o n

s c h e d u l i n g may f a c e p rob l ems and d e l a y s and as a r e s u l t f i n d

much l a r g e r amounts l i e d up in t h e w o r k - i n - p r o c e s s i n v e n t o r y .

MANAGEMENT OF FINISHED GOODS;-

F i n i s h e d goods a r e t h o s e goods t h a t have been comple t ed

and a w a i t i n g f o r s a l e . I n v e n t o r y of f i n i s h e d goods p l a y s a

ve ry v i t a l r o l e in t h e i n v e n t o r y management . S t o c k s of

f i n i s h e d goods mean g o o d s - a w a i t i n g f o r s a l e . They a r e t h e

f i n a l o u t p u t of t he p r o d u c t i o n p r o c e s s as f o r as a m a n u f a c ­

t u r i n g company i s c o n c e r n . In case of r e t a i l f i r m s and

- 62 -

wholesalers, they are usually refferred to as the merchandise

inventory. The increase of inventory of finished goods means

low sale. Therefore, basically it is the duty of the sales

manager to see that inventory of finished goods should not be

increased. They should promote sales to clear the inventory

of finished goods. Since stock of finished goods contribute

to a good percentage of total inventory cost it is also an

important part of the inventory management. When stock of

finished goods inventory increased, it exposes a number of

risks and costs there should be a trade off between having

too little and two high inventory. We have see the risks

and cost in achieving this trade off. Some costs have less

risk as aome other costs have higher risk. Our purpose should

be to reduce risk, hold down costs and increase revenues. To

keep the inventory carrying cost of finished goods as much

as possible, two aspects come into way.

1. Sales Aspect; - As inventory of finished goods increases

due to less sales, so efforts are to be made to promote sales.

Following points are to be observed for this:-

(a) Stop production in view of sluggish demand and already

high inventory with the company.

(b) Produce goods with expectation of sales in future.

(c) Produce a product which may have lower profit margin

but immediate sales prospects instead of an item which

has higher profit margin but low sales prospects.

- 63 -

(d) To promote sales by giving discount to clear inventory

keeping in view the inventory carrying cost. Discount

should not increase that the inventory carrying cost.

(e) To change products, sizes, designs, quality etc.

(f) To change packing material to attract the market.

(g) To start a bonus scheme keeping in view the profit

margin.

These above steps are taken by the inventory manage­

ment with the help of production people and sales people.

Actually, it is the duty of sales management and production

management to keep a proper watch on the finished goods items.

They should produce those things which are easily acceptable

by the market. Marketing management also plays a vital role

in this aspect.

FINISHED GOODS INVENTORY CARRYING COSTt-

Inventory carrying costs are the those expenses which

are incurred in storing goods. Classifications of finished

goods inventory cost will be done by way of capital tied up

in the inventory at all stages. For example, in plant

premises till such time as no excise has been levied the

cost consists of only the fixed and variable cost elements,

while in transit the cost consists of excise paid and the

transit charges being incurred. At the depot the cost further

goes up and includes the distribution expenses and other

64 -

indirect expenses as incurred in the godown. Finished goods

inventory carrying cost has following kinds:-

1. Storage Cost:- Storage space as ware-house or supply room

is needed to store the finished goods, to look after it

workers are employed. Labour is employed to mo e, clean

record and protect the goods.

2. Insurance:- Insurance is necessary against hazards like

fire or accident in warehouse. Insurance premium represent

finished goods carrying cost on inventory.

3. Obsolescence and Spoilage:- Obsolescence and spoilage

are two different inventory carrying costs. Obsolescence is

the cost of scing unable to sell goods because of current

market factors deriving from changes in style tastes, or

other factors. Spoilage cost occurs when a product is not

selable because of deterioration during storage, like foods

that rot plants that die.

4. Damage or Theft:- In spite of all efforts there are

chance of damage of goods and theft this loss will not be

covered by insurance and becomes an item of inventory

carrying cost. It is the job of the inventory control

department that they should keep a vigilant watch on the

stocks of transit and depots. Stocks in transit and depots

should not go high as it includes the cost of excise,

distribution expenses and other indirect expenses. Food

back should be in such a way that depots should have minimum

- 65 -

stock level.

CASE STUDY ON BUILDING THE FINISHED GOODS INVENTORY FOR

FUTURE SALEr-

Problem Definitiont- One of the basic objectives of contro­

lling the finished goods inventory is to maximise the sales

or market share in such a way so as to optimise the profits.

Often the problem in a multi product company is to make a

choice between the product which may have lower profitability

but immediate sales prospects instead of one which has higher

profitability but lower sales prospects.

IN ABC Company there are different type of products

and their salability keeps on changing. The choice has to

be made between making product 'A' or product 'B' or product

'C or product 'D' depending upon the market condition.

Following data were collected to illustrate the problem as

above.

PROBLEM DATA;

It was found that the company could produce 4000 'A'

product with given production constraints in the same period

the company could produce 3000 'B' product with no additional

production cost from the point of view of production. Other

relevant data is as below:

66 -

c = Unit inventory carrying cost per day at 18% cost ^1 of the capital on manufacturing cost of te.800/=

per product.

c = Cost of deterioration per product which is Re.l/= 1 per product.

c, = Net profit which is Rs.50/= per product

In case of product 'B':

c„ = Unit inventory carrying cost per day at l&fo cost of the c{ Rs.l050/=

^1 of the capital for the manufacturing cost of

Cj = Cost of deterioration per product which is RS.2.5

c^ = Net profit which is 8s. 50/= per product.

The problem before the company is whether to product

4000 A products which has possibilities of being sold after

being retained in stock for 30 days. On the other hand

other is equal chance of seeling 3000 B products after about

80 days. The problem which is being faced is whether to

make and store 4000 A products or to make and store 3000 B

products with the expectation of sales in the future as

already ax outlined.

CHOICE OF DECISION PATHS & A PRODUCT:

Cgj = 800 X.05/100 = GS..40 per day product

C.. = Re.l/=: per product

Cl = Bs.50/= per product

n. = 400 nos.

m J = 30 days

- 67 -

Therefore in case of the A product total profit

contribution is;

= ^ ^1

= 4000 X 50

= Rs.200,000

The t o t a l cost of ca r ry ing the inventory and o the r r e l evan t

cos t s are as fo l lows :

= '^cl " l " l ^ "dj " l

= .40 X 4000 X 30 + 1 X 4000

= 48,000 + 4,000 = RS.52,000/=

The net profit, therefore, in case of product 'A*:-

= 8s.2,00,000 - 8s. 52,000 = Bs. 148,000

for product 'B':

c^ = Unit inventory carrying cost per day at 18^ cost 2 of capital of manufacturing cost of the product.

= 1050 X '^- = fis, .525 per day product

c, = Cost of deterioration per product ^2

= Rs. 2.5 per product

n^ = 3000 nos.

m^ = 80 days.

Therefore in case of product 'B' the total conibribution is:

"2^2

= 3000 X 150

RS.4,50,000

- 68 -

The total cost of carrying inventory for this period and

other relevant costs are:

c n„ in_ + c . n„ s 2 m 2 '^2

= .525 X 80 X 3000 + 2.5 x 3000

= 126000 + 7500

= .8s. 1,33, 500

In case of product 'B* therefore:

"2̂ =2 % 2 "2 "2

+ c . n„ ^2 2

and which gives the necessary as well as sufficient condition

of :

^̂ 2 ""2 " ^^2 "2 "'2 + ^d2 "2^

= 8s.4,50,000 - 8s.1,33,500

= 8s.3,06,500

It may be observed that necessary and sufficient

conditions for making the product 'B' is as below:

°2 ""2 - ^%2 *"2 •"2 + ^d2 n"2)

^ ^ S - ^ % j - " i " i ^ ^d^ " i )

The above c o n d i t i o n i s o b s e r v e d a s :

Rs .3 ,06,000 Bs.1 ,48,000

The company w i l l s t a n d t o g a i n RS. 1,58,500{lf= by

c h o s i n g the a l t e r n a t i v e of p r o d u c i n g t h e p r o d u c t ' B ' .

- 70 -

MANAGEMENT OF STORES AND SPARES INVENTORY CONTROL;

Apart from raw materials, a manufacturing firm has

to cary inventory of stores and spares and purchased

compnents etc. Many of the methods of stores and spares

inventory control are similar to the raw material inventory

control. Methods like Kardex system and Two Bin System are

quite common and everyone in the industry is aware of these

techniques. I feel no need to go in details for these systems

In large size manufacturing firms the number of stores

and spares can be any thing from 15,000 to 30,000. Taking

their inventory at the end of the financial year is impossible

because of the huge work Involved in counting each and every

item or weighing each and every item.

Perpetual Inventory System;

Perpetual inventory system is a system by which one

can keep track of inventory. This system is in addition to

the system for establishing stock and reorder levels for

individual items. In simple words a perpetual inventory

system is a continuous stock taking system spread over a

period. The important items, may be subjected to more

frequent and larger number of varifications during the year.

The main advantage of this technique is that plant operation

does not disturb while taking the stocks/inventory.

- 71 -

Items that are to be verified can be selected at

random, such that the items chosen for surprise check are

as near to minimum levels as possible, as per stock records

or bincards. The verification is easily done in this instance

unlike the annual inventory where luge inventories of some

items might pose serious counting or weighing problems. With

the amount of the work reduced, a larger number of items of

inventories can be cerified each day then would otherwise

be possible. If on verifying the count of the selected items

shortages are spotted the situation may call for immediate

action to replenish stocks. Thus, the perpetual inventory

system provides verifications of the information furnished

by the bin cards and enables correction of recording errors

rending them reliable as baisis for inventory decisions.

Perpetual inventory system coraples prompt updating

of stock records on a continuous basis. The personnel who

are assigned the task of physical verification of stocks

under perpetual inventory system are experienced and familiar

with the items, and can identify them properly. In annual

stock taking, many employees who are unfamiliar with the

items may be engaged to verify the inventories and the

possibilities of wrong identification and counting errors

are higher. Moreover, perpetual inventory helps prompt

detection of discrepancies facilitating speedy investigation.

Johm J. Hampton has given following figure for need of

inventory

Afo id JoBse« of sales

' PurchasMSi

r ,

r F irms Hold

InTentoriesi

To 1

Separate Producing

Selling

Why Firms, Hold Intentory

1

I Gain quant 11y|

d iscoant 8

khicli

he Ip

Reduce order

costs

AchleTe Efficient Production

- 73 -

Annual stock taking highlights the discrepancies long after

the occurrence, in most cases, and is less effective.

CASE STUDY;

In ABC Company limited there are total 13000 items

out of which 8000 items are stock items. These are those

items which are either insurance spares or consumed regularly

or consumed by more than two users. Items of capital nature,

obsolete nature, very rarely required or raw materials are

not included in stock items.

To keep proper control over these 8000 items, the

following steps are taken:

(a) There is a bin card system in the factory under the

store department for proper recording of the documents.

(b) Perpetual inventory system: There is perpetual inventory

system in the factory. For this job, a separate cell has

been set up under Accounts department. This cell takes p

physical stock of all the items in such manner that consu­

mables are counted at list twice a year and insurance spares

once a year. They also check bin card stock against ledger

stock taking at the time of finalisation of balance sheet.

lo keep proper control over inventory the following

procedures are also adopted in a ABC Company Limited.

- 74

1. CODIFICATION

Since number of items in ABC Company are very large

and also for easy identification of individual item for

detailed specification, a coding scheme has been introduced

whereby each individual item is given a separate code and

a standard unit of measurement. After giving code number

it becomes very easy to control every item separately. As

it helps in counting etc.

Code is of seven digits. Each digit indicates some

specification of the material. Given below significance of

each individual digit:

i All the items are devided in two main Groups:

A. General Items

B. Spare Parts

GENERAL ITEMS: 1st digit of item code means; main group

Ilnd &3rd digit of item code means; sub-group

4th-7th digits of item; Flexible digits

SPARE PARTS;

1st digit is common, specifying that item is spare

2nd to 4th : Equipment

5th to 7th : Flexible digits

- 75

INDENT VERIFICATION

Material is purchased by the Purchase Department only

against specific indent, which is i-aised either by

stock Control Section, for items which have been

declared stock card items under authority of Plant

Manager or by the individual User Department.

- Such idents are authorised by the Departmental Heads

only. For items of personal use, furniture, capital

item and costly items indents are put up to the

Management for sanction.

All indents other than stock card items are sent to

the Issue Store for verification of stock in hand.

Issue Store indicate the stock availability against

individual item on indent and send the same, after

giving a running serial no., to Purchase.

Purchase procures only such material which is not

available in Store.

Issue Store also suggest use of alternate material,

if available in the Issue Stores, for keeping the

inventory to the minimum extent.

ABC ANALYSIS;

Since hold of inventory means hold of finance. So

every item of inventory is valued in rupees. Basically, it

has been observed that there are three types of items in

every manufacturing unit. Some are those items which are

- 76 -

of high value. Some are those items which are to medium

value. Some items are those which have minimum value. To

segregate these items ABC analysis system has been intro­

duced. In this system, an analysis of items and their

value is made in order to show how inventory value is

concentrated amongst the individual items. This analysis

is made by classifying the items in three categories i.e.,

A, B and C. Classification is based on value, usage rates

and criticality. The items are taken by their value and

then the accumulated percentage of each item is related

to the total value of all inventories. Generally the

analysis comes:

1. 10^ of items hold 10% of the value

2. 20^ of items hold 20% of the value

3. 10% of items hold \0% of the value

CASE STUDY:

A thorough study of ABC analysis system introduced

in A.B.C. Company was made and found that

1. (i% of items hold 80^ of the value

2. lOfo of items hold 10?̂ of the value

3. 84^ of items hold \0% of the value

From the above statement it will be realised that 6% of items

are carrying 80^ of the value so management should pay more

attention for controlling 6% items instead of wasting time

- 77 -

in 82% of items which carry only 10^ of the value. Key

items are the 6% attention should be given to their

attention paid in controlling the 6% of items may decrease

the inventory cost of the factory. The 6% of the items are

high value items and are to be considered in A category,

10^ of the items are medium value item and are to be consi­

dered in B catagorj and ~Q2% of the items are having low

value and cansidered in C catagory. So different control

mechanisms have to be devised for each category. For the

best control and to reduce the cost more care and attention

shoudl be paid to A category that are 6% tf the items

category. And less attention should be paid to C category

that are d3% of the items with 10^ of the value.

APPLICATION OF STANDARDISATION;

When we go for codification, we group all the like

items together which makes it easy to examine the complete

range of any given type of stores and consider whether the

number of verities can be reduced. In every factory,

there are some items which are very similar in function,

but points are to be seen whether it is economically possible

to fix a standard of various varities. For example, in a

factory where different types of electric bulbs are required

liKe 60 watts, 40 watts and 25 watts it is to be seen

whether it is economically feasible to keep only 40 watts

DS W,s-

- 78 -

bulbs or 25 watts bulbs Instead of keeping all the three

items. This can be visualised with the help of consumption

value and functional value. In case with the help of

standardisation, we reduce the variety we can get price

discount in purchasing bulb quantity.

- 79 -

PROCEDURE FOR RECEIPTS AHD ISSUE OF MATERIAL ; ACCOUNTING !

Any purchse results from demand created by the pro­

duction or other using departments in the factory. In case

of raw materials, to achieve a particular level of production,

the material breakdown is provided by the Chief Chemist

(Production Planning Department). With this information,

the Purchase Department recommends the approved levels of

inventory, giving due consideration to location of suppliers,

value of the material involved, the availability of raw

materials etc. The Purchase Department obtains approval

from the Management for (A) level of inventory to be main­

tained in the plant (expressed in month's requirements),

(B) quantity that should always be in transit (expressed

in month's requirements), and (C) quantity that should be

'on order' with the suppliers (expressed in months' require­

ments). The approval is on the basis of stocks for each

class rather than for each raw material. Purchase Department

together with the Cost Accounting Department reviews the

actual Inventory tie-up every month and corrective action

is taken by the Purchase Department to achieve the desired

levels of inventory.

The purchase department maintains Cardex Control and

order are placed to arrive at a particular approved position

- 80

every month. As such, the purchases are made against

requis it ions.

In the case of engineering and other consumable

stores need in the plant all items, which are required to

be held in the stores are by a request for inclusion in the

stock list. This is recorded.

The document for inclusion in stock list is knwon as

"addition to stock list". These documents are pre-numbered

and the using departments issues them in three copies and

are approved by the respective departmental heads. This

is further counter-signed by the Plant Manager/Chief

Engineer concerned, purchase Manager and the President.

After final approval one copy is retained by the orglnating

department, second copy is to the Purchase Department and

the third copy which is known as "travelling requisition"

is filled by the MRO stores. There are provisions in the

card to indicate maximum and minimum stock leiele, the

recorder levels etc. Except when it is a first purchase,

whenever stock level reaches the reorder level, stores

pull out this "travelling requisition" and is routed to

the using department from where it originated to determine

whether further purchase of this item is necessary and also

to review maximum and minimum level of stock indicated

therein. This procedure of routing "travelling requisition"

- 81 -

is not followed for items failing under consumable stores

which are repeatedly consumed in the factory. MRO stores

need not to fill the third copy as travelling requisition

for this. If the originating department feels it necessary

that the stock must be replanished, this card is routed to

the purchase department for further action.

The Purchase Department after placement of the order

sends back the "travelling requisition" together with the

purchase order copy meant for the stores. If, for any

reasons, any particular item is not required to be reordered,

the using department mentions in the "travelling requisition"

the reasons for not ordering again and also state whether

the quantity in stock at the time of routing the "travelling

requisition" can be sold/disposed of. The using department

recommends deletion of the items from the stock list, if

deemed necessary. This whole system is adopted for the

requisition of raw material as accounty system. If does

not include in issue of raw material to the different

department. Although issuing is also recorded along with

these cards. Which helps in determing the level of raw

material in sote.

- 52

MANAGE\iENT OF RECEIVABLES;

Average collection period in this company is two days.

At depots and at Plant goods are delivered to the suppliers

against Bank drafts or cheques drawn on local banks which

takes one to two days in collection. If goods are sent to

the supplier through the Bank, Coraapny gets immddiate

payment from the Banns as they have DD limit facilities

with the Banks upto 100 lacs. If dealer retires the

documents after grace periods of seven days he is responsible

for the payment of overdue interest for the delayed period.

This is a very good system and I did not any draw-back

in it. System is satisfactory and suggested to be continued.

83 -

MANAGEMENT OF PAYABLE;

Except of very few suppliers which takes the money

in advance before making any despatches to the paint. It

is find that all other suppliers are giving credit facili-

lities to the company ranging from 7 days to 90 days. Most

of them except Rubber suppliers which are charging interest

for full credit period, are giving interest freecredits.

Some of the suppliers have monopoly over the market. They

sell their goods on their omn terms. But there is no

other way for the company to cope with the situation.

Other suppliers are also giving their best cooperation in

the smooth running of the factory by their continuous

supplies. We do not see any major draw-back in the system.

Payments are being made by the head office and they have a

good control over the management of Receivables.